I just wrapped up my taxes for the year. It was a hassle, but it was a lot easier than last year, and MUCH easier than four years ago. Over the years I’ve realized that a lot of the accounting pain associated with stock investing is actually avoidable. Below are some tips and tricks to minimize your tax-time blues:
1)Dollar-cost averaging sucks! Sure it works great as a strategy(you buy more when things are less expensive), but all those small transactions are difficult to account for. They make calculating your cost basis a lot harder. This insight leads to three sub-rules.
a)Never buy the same stock or mutual fund twice
b)Never select the “reinvest dividends” option when buying a mutual fund.
c)If you want to buy the same thing, just settle for a “similar” thing instead. For example, instead of buying an S&P 500 mutual fund, buy a DOW mutual fund. Then buy a DIFFERENT S&P fund. Then buy a DIFFERENT DOW fund.
2)Churn is good. A lot of the pain in doing your taxes comes from the forensic accounting that you have to do. Lets see, I bought this in 1992, it split 3 times, spun off 2 companies, and I changed brokerages. What was my cost basis? It’s enought to drive a lesser man to drink. Selling frequently means that you never have to dig more than a couple years back into your records. Of course you take a tax hit, but that’s a small price to pay for having a simple tax return.
3)Retirement accounts are a godsend. Always maximize your contributions to these every year. Not for the tax savings… but for the accounting savings! IRAs are like Vegas: whatever happens there stays there. Make sure you segregate your records: put the IRA stuff in a seperate folder so you don’t have to look at it when preparing your taxes.
4)Mutual funds are better than stocks. Not for the traditional reason (better diversification), but because they don’t do all the crazy things that stocks do. Splits, reverse splits, spin-off companies, de-listng, shareholder lawsuits, all of these can create headaches come tax-time. Mutual funds pretty much just increase or decrease in value.
5)Never, ever close an account. Last week I had to download data from an account that I had essentially emptied in 2000. Thankfully, I had left a token sum of money there, so I was able to log on and look at my records. Once you close an account, the brokerage loses all motivation for helping you with your accounting.
6)Keep your money with a decent brokerage. A well-run brokerage gives you good reports on cost-basis, has a well-designed UI, and provides downloadable records that actually make sense. Schwab is the best I’ve tried. In my experience, the cheapies (etrade, Ameritrade) and the richies (Salamon Smith Barney etc) just don’t have their act together here.
7)Keep good records. This means NEVER accept electronic records instead of paper records. You _need_ a paper trail. It also means you should downloading your data in csv format from the brokerage and archive it somewhere safe.
That’s it! Obviously, this isn’t the most tax-efficient strategy, but it will definitely make your life simpler. And simplicity is priceless.